Should investors expect another equity sell-off?

Should you be selling stocks? Only if you think growth will disappoint.

That’s the advice coming from JPMorgan on Monday, after last week’s sharp correction in equities that began on fears of inflation and rising interest rates, and quickly morphed into a surge in volatility, with alternating waves of fear and greed.

With global equities hovering around correction territory, as the MSCI World Index and S&P 500 both started the week down about nine per cent from their January highs, confidence in the market has clearly been damaged by the spike in volatility.

However, typical sources of market contagion are not flashing warning signs, according to JPMorgan equity strategist Mislav Matejka. He noted spreads in the credit and peripheral bond markets have remained reasonable, metal prices haven’t plunged, and real policy rates are still negative — an important factor given that no economic downturn has begun with real rates below two per cent.

Meanwhile, the earnings outlook and analyst revisions remain positive, higher wages usually drive growth, and inflation supports corporate pricing power.

Matejka noted that while growth and earnings are critical to the medium- term outlook for stocks, neither is indicating a reason for concern.

“Only a deterioration in these could drive a sustained selling,” the strategist said. “Most tactical and sentiment indicators have gone from complacency toward fear.”

Matejka also pointed out that in each instance of the VIX spiking more than 50 per cent compared to its past month average in the past 30 years, equities were higher during the next three months, outside of recessions.

If the market were to fall further, the strategist believes this could only happen if cyclicals and financials lead the way on the downside. He also noted that the hedge provided by shorting defensive sectors like real estate and utilities, is a trade that has likely run its course.

“In other words, we don’t see equities falling much further without central banks turning more cautious, and believe that bond yields will not be able to move much higher in that scenario,” Matejka said. “The negative correlation between stock and bond prices is not dead, in our view, it will quickly reestablish itself and ultimately provide a valuation cushion in case of further equity weakness.”

With the MSCI World and S&P 500 having erased their gains of the past two months, the indexes are only a few percentage points above where they were in early September. As a result, most of the tax rally gains have evaporated.

Spiking interest rates and inverse VIX ETFs are taking most of the blame for the recent sell- off, yet Ian de Verteuil at CIBC World Markets noted that it has not been accompanied by significant concerns in fixed income or foreign exchange markets.

“This is relevant because bond markets are generally better predictors of systemic risks,” de Verteuil said. “We still think equities are the preferred asset class.”

From his perspective, little has changed. North American business fundamentals remain positive, and U.S. economic growth could accelerate. “This risk remains that interest rates move too far, too fast,” the strategist said, adding he doubts this would bring an end to the bull market.